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Ripple Explained Guide Version 1.97

by Andrew White andrew@onemilliongateways.com twitter @OMGateway

Copyright 2014 ­ Andrew White

Hello and welcome to the Ripple Explained Guide. This book is only for educational purposes, and is not intended to provide investment advice. My goal for this book is to be largely non­technical and, as the author, I feel a certain responsibility to make sure everyone who reads this book learns something of value. I apologize in advance if there is anything in this book that is too technical or too complicated. If there is a passage in this guide that does not seem to make sense or is too complicated I ask that you don’t give up, keep reading and come back to it later. Take your time with each section and supplement your learning with Google searches to help get the answers on terms or areas of interest. Throughout the text I include links for you to follow up on for further research. When you are done learning all the information below don’t be surprised if after reading this guide you become the “go to” expert about Ripple in your social network! In my opinion the Ripple payment system is one of the most exciting technologies to be developed in recent years. For the first time, payments can be sent to anyone in the world in any currency within a few seconds. I describe Ripple like “email for money.” But even better than that is that activities that were once the sole purview of the banking industry, such as lending or making payments, have become democratized in the Ripple system. The myriad opportunities and challenges these new options bring to the masses open a whole new set of possibilities for the discerning entrepreneur or investor to consider. This ebook presents a brief overview of business opportunities in the Ripple ecosystem and what roles you can play in this exciting new area of finance. I have been involved with Ripple since early 2013 and I have experienced all of the difficult questions of Copyright 2014 ­ Andrew White

trying to wrap my head around it. After I began talking to public about it I quickly learned that everyone asks the same questions and one way to satisfy those questions is to write a book ahead of time. So on that note I want to cover the major components of Ripple as it exists today and dive deeper into each topic but without getting into the gritty details. So with that said with any new technology there are tradeoffs between sophistication and ease of use, new features and complications, new capabilities and new risks, and Ripple is no different. This book was started in December 2013 in a dozen pages. Over time it has expanded over 39 pages and my intent is make you conversant in the main areas of Ripple and invite you to continue in your own area of research. Best wishes, Andrew White Acknowledgments: I would like to thank the following people with their help in this document: Fred Laughter for editing, Ripple Labs for permission to reuse their images, and the Ripple community for making valuable feedback and suggestions.

Copyright 2014 ­ Andrew White

Table of Contents Ripple Labs Wallets Ripples Gateways Consensus Currency IOUs Traders Market Makers Enterprises Due Diligence Questions In the Future Important Ripple Infrastructure FAQs Glossary About the Author

Copyright 2014 ­ Andrew White

Why Digital Currency? Before we get into Ripple I’d like to provide some background information about what currency is and what is happening with currencies in general. I recently got back from a conference called Money2020 and had a discussion with a friend that explained the importance of digital currency in terms of human history and I thought I would relate that story here. Before we begin we should define what a currency is, and it is usually defined to have the following six traits: Durability, portability, divisibility, uniformity, limited supply, and acceptability. Someone else (I have not been able to find the name of the original author) explained these in the following manner: “Acceptability: In terms of a form of currency being accepted within society, money must be accepted by everyone in the economy. This acceptance is for the purpose of the exchange of money for goods and different types of services. Divisibility: This relates to money being easily divided into smaller denominations for transactional purposes. People will only need as much money as is necessary for their purchases, therefore it is necessary for money to be easily broken down for different types of transactions.

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Durability: This simply refers to the physical wear and use of money over a period of time. If some money is easily destroyed or damaged it is likely that it is fraudulent and therefore cannot be trusted. Yet, money is made from a paper source, so some wear and tear must be expected. Limited supply: In order for money to retain its worth, there must be a type of limited supply. The more money that is in circulation the less it is valued by the economy. Portability: Quite simply it is necessary for money to be easily transported so that people can carry it around with them on a daily basis. This also allows for the ease of transaction so that money can be transferred from one place to another. Uniformity: Depending on the different types of currency that are available, money within that specific currency must look the same. This also allows for money to be counted and measured accurately. An alternative way for distinguishing the characteristics of money is that it is easily recognized. Money is subject to the type of currency that is in circulation within a specific place, so if it is easily recognized and it follows the above characteristics, then it is likely to be genuine.” For these reasons, the physical metal gold has been used as currency for the last five thousand years. The reason for this is that the gold metal has characteristics that make counterfeiting it impossible. For centuries alchemists attempted the impossible by transforming baser

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metals like lead into gold but with the more modern science of chemistry it quickly became understood that this was impossible. However using gold as the sole currency is problematic for economic reasons. For of all it can have substantial weight. It’s hard or expensive to secure. Sending it to someone else is difficult to do securely. And there simply isn’t enough of it for the world’s expanding population as only a consistent amount can ever be mined out of the earth. Thus it became popular in recent centuries to represent gold in paper money. To assure people of the intrinsic value of the paper bills, the face value of the dollars was backed by certain amounts of gold or silver was promised to the note holder. However as most people know, this creates an additional problem as conterfeiting paper money is easy. Famously (or infamously according to some) in 1972, Richard Nixon took the United States off the gold standard and pegged the value of the US dollar to a new measure of economic fitness called the Gross National Product (but we won’t get into all the reasons for that). With the GNP the value of the dollar began to be created in digital systems. In the present day this has evolved so much that some economists believe that electronic systems make up 95% or more of all monetary transactions. This has been good for society because it makes the cost of using money lower for everyone (and that’s a good thing). Credit cards are one of the most frequently used tools for doing this. Credit cards were invented in the time before the Internet (Western Union started a card program in 1921!). However as most people know the underlying problems of earlier generations of currency, fraudulent use of the tool is a very expensive problem that the incumbent players have not been able to fix and about 1% of all credit card transactions are fraudulent. In 2009, Bitcoin’s release solved the issue of how to make a digital currency and be practically impossible to counterfeit. Bitcoin uses some special applications of

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math and cryptography to make counterfeiting it nearly impossible. This is wonderful for merchants since the high costs of handling fraudulent transactions is eliminated. Understand that the near impossibility of being counterfeited is the key fundamental reason for the growth of Bitcoin style currencies online. It is nearly impossible to counterfeit for reasons that will be explained later but the main reason is due to the reliance on a particular math function of cryptography, more details can be found in the FAQ at the end of this book. Proponents of digital currencies that understand this claim that this makes digital currencies a better store of value and exchange than gold, which is an awe inspiring leap in human progress if the premise holds to be true for a sufficiently long period of time. Only time will tell if the claim stands up to scrutiny. Now that we understand the basic reasons to justify a peer to peer digital currency, soon we will learn how to build a peer to peer exchange using Ripple.

Ripple Labs First let’s start with a definition of terms. “Ripple” is the name of a new payments technology. Ripple is developed by a company named “Ripple Labs Inc.” in San Francisco. Originally the company was formed as Opencoin Inc in 2012, and later reformed in 2013 by Chris Larsen, Jed McCaleb, David Schwartz, and a few others. Ripple Labs owns the intellectual property of the Ripple protocol and the Ripple name but the code and programs that make up Ripple are available for free for anyone to download, use and modify as they see fit. Ripple Labs software is extended by a community of Ripple enthusiasts around the world who are passionate about making the technology

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more useful. These people provide essential feedback to product teams and engineers leading the overall implementation of Ripple’s development. The known investors in Ripple Labs include Google Ventures, Andresson and Horowitz, Lightspeed Ventures, Bryan Bradford, and others. As of October 2014, Ripple Labs has a staff of 60 people led by CEO Chris Larsen. Mr. Larsen is the former CEO of ELoan and later Prosper.com, both of which were pioneering companies in peer to peer lending. As an outsider, I can’t say anything definitive about Ripple Labs’ specific business strategies. But their actions show that they are committed to increasing the value of the Ripple network. They do this through a variety of strategies to show the public that Ripple provides a better system for payments than the alternatives. One of the ways of accomplishing this is by making useful software and giving it away for free. The source code of the software from Ripple Labs can be read and used by programmers at no charge, which is an open invitation for curious engineers and programmers to make contributions to the code and expedite the development of the core functionality. This also provides a valuable safety mechanism. Since more eyes can look at the underlying code, potential issues can be identified and fixed early, before becoming a serious issue. Ripple Labs can give away the software for free because the core value proposition of Ripple is that an open payment network that anyone can use and improve is more valuable than a closed alternative. So far the plan seems to be working well and Ripple is starting to make big waves.

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If we look at the hierarchy of financial services in the United States, Ripple is designed to replace the American Clearinghouse (ACH) payment settlement system. ACH was invented in pre­Internet era and is a major drag on the efficiency of moving money. Another system that European’s would be familiar is called Swift. Swift is a newer protocol for payment messaging and it works a lot better than ACH but the problem is that US banks don’t use it domestically. Swift is faster than ACH, same or next day payments is the norm and other countries like China and Mexico use a similar system. But whereas Swift is specifically a payment messaging protocol and not a payment settlement protocol it still involves a lot more work for financial institutions to learn “who has what.” Ripple offers a solution that offers real­time (about five second) payment settlement and payment messaging (that might be a statement that looks like “This payment is for Bob’s new shoes”). Since Ripple combines messaging and settlement some smart people have been calling it “Swift 2.0” but Copyright 2014 ­ Andrew White

Ripple is really a lot more than that. So with that in mind let’s dive right in to experience what using using the Ripple payment system looks like.

Wallets To use an online payments system, people start by creating a digital version of a wallet. A wallet consists of a name of who owns the wallet and some sort of security mechanism, like a password, to limit access to the account. It should be important to keep in mind that not all wallets are created equally. Many traditional online wallet solutions allow themselves the privilege to close your account for any reason. Their are a variety reasons for this but a Ripple wallet is different, it is impossible for anyone, including the makers Ripple Labs, to stop someone from accessing their Ripple wallet. I will explain a bit more about how that works later but for now let’s move on to what the wallet looks like. There are two ways to identify who owns a wallet. The first is called a “Ripple name” and it looks like “~SomeRandomWalletName.” Anyone that knows this wallet’s name can send payments to it. Under the hood the name is tied to the public name of the Ripple address that begins with the lower case ‘r’ and looks like this: r3CxMDQFX1Atq1vQN5sqVsjm3rawGSwd32 (note: donations to the author are welcome!).

Copyright 2014 ­ Andrew White

This is an example of what a RIpple looks like available at https://www.rippletrade.com A Ripple address should be thought of like a physical address where mail (or payment messages) can be delivered. The password should be thought of as the key to open the door to the house. In the prior two sentences I just taught you the basics of “public key cryptography,” feel free to Google that for more information. So the wallet is always available on a web page and has the following functionality: wallet transaction history, an address book, a section to send and receive payments, and a section of the wallet for you to make currency trades. And that is about it. It is important to note that Ripple wallets are not insured by the Federal Deposit Insurance Corporation (FDIC), which was created by the U.S. government to protect consumers from bank failures. For most consumers, the power of Ripple payments happens when payments are sent across the network within a few seconds. To anyone accustomed to the slow and cumbersome process of Copyright 2014 ­ Andrew White

traditional payment networks, this is an incredible advance in payments technology. No longer do people need to wait for days for a bank wire transfer to be completed, or weeks for a credit card payment to be processed; with Ripple, having to wait for payment processing is a thing of the past. Even in areas with modern banking systems (like Europe and China) with same day bank transfers, the existing payment system is still a relatively slow and costly process that creates an unnecessary drag on the economy. Just imagine what kind of low­cost new services will become available with Ripple to merchants, consumers, and investors across the entire global economy. As far as most users are concerned, the Ripple wallet is also where “magic” happens in its role in redefining the payment experience around the world. To be honest, in my opinion, wallets are not all that interesting visually, or conceptually, nor should they be particularly interesting. They are designed to be as simple as possible hence there isn’t much to see or do in a Ripple wallet (with the exception of trading). Advanced concept warning! I like to describe Ripple wallets using the following example but it is not a precise analogy. I just mentioned that Ripple wallets are not FDIC insured because they are not issued by a U.S. chartered bank. Allow me artistic license with the following analogy: a Ripple wallet is kind of like a bank account but you as the wallet owner (account owner) are empowered to control how much money you trust to be held by your various bank like entities (gateways, more about them later). Ripple Wallets are great because when they can store or make payments in any currency. The author can’t think of any other wallet ever created that is able to accept any currency ever created, including government issued currencies and private currencies! For

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the first time in history, digital wallet users can hold any currency ever issued. This is a Big Idea that may take years to be widely understood, appreciated, and accepted by the market.

Ripples “Ripples” are “access tokens” used by the Ripple protocol and are referred to a currency code of XRP (which is like USD or BTC). The protocol consists of the rules of how Ripple works and these rules are translated by professional programmers into software to perform all the functions that Ripple delivers. More generally, people make protocols to solve a problem in a consistent and entirely reliable manner. Well designed protocols share a number of traits. For example, think of the protocol of shaking hands when greeting someone. This protocol has become instantly recognizable worldwide. It’s notable traits are that it is simple, easily reproducible, and cooperative in nature. The best computer protocols and monetary systems aim for similar results. To be consistent with international naming conventions, Ripples are known by a three letter acronym, comparable to how US dollars are represented as USD. The three letter code is XRP. The Ripple concept has been around prior to Ripple Labs. It was first worked on in 2004 and later on in 2011 the core team around Ripple Labs was formed who then released it to the public in the beginning of 2013. Every time you use Ripple, a really tiny amount is deleted to make sure the network does not get overloaded by payment messages. The logic is that average consumers might only need to use a relatively few Ripples across their entire lifetime. Ripple was released with a hard limit of 100 billion units of XRP to ever exist. The 100 billion number was judged to be large enough to be useful for the Ripple

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network for hundreds of years, and quantifiable enough to provide a business model for Ripple Labs. Once Ripples were created the next step was to figure out the best way on how to distribute them in the most effective manner. It is critical to the Ripple Labs business strategy that XRP be distributed to a wide number of market participants who intend to use Ripple as a system for payments, currency trading, or asset issuance. A cool feature of XRP is that as the native currency (I like the term “meta currency” but it is not as completely obvious as to what that means), XRP can be spent to send (or receive) any other currency offered for sale inside the Ripple network. Ripple Labs also sells bulk quantities for large orders and gives away smaller amounts for free. In large part their target market are banks to use XRP to make interbank payments and facilitate international trade. So now that we have covered a bit of how much XRP there is, what it is used for, and Ripple Labs role in the distribution of XRP, let’s move on to investment opportunities in the space. There are different investment strategies involving Ripples and a large number of people trade them against other currencies for speculation. Before getting into the various choices available, I would suggest would be investors ask themselves a few questions such as: “Am I technically proficient enough to handle digital currencies on my own?” “Do I always follow best practices for computer security?”

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“Should I rely on a reputable consultant, broker, or hedge fund to manage my investment?” “Am I well versed in the nature of online scams, wallet security issues, and legal issues before buying?” “Should I use XRP as a hedge against my other investments?” Your answers to these basic questions should help point you in the direction that’s right for you. It doesn’t help to be less than entirely honest with yourself, so be candid and assess your strengths and weaknesses before making any investment. Investors must be aware that there are inherent risks associated with digital assets. Thefts and scams are an unfortunate but inevitable aspect of online offerings and the investor must always perform due diligence before trusting others with their money. Even if an investment is not fraudulent, there is no guarantee that the value of the investment will yield profits. You are completely on your own on this one. Ripple Labs cannot and will not comment on the investment fitness of Ripple, XRP, or the value and safety of claims made by non­Ripple Labs staff. Due diligence is the process of investigating a proposed investment, and the responsibility for due diligence is entirely up to you. Be appropriately skeptical and cautious in all your dealings. At first they were worth nothing at market rates, but XRP has steadily increased in value through a steadily increasing number of services built for it. Although the price of XRP has been relatively stable, it is not immune from drastic price swings similar to a penny stock. Although currently valued for less than a penny, Ripples are really only useful for making transactions on the ripple network but speculators on the Ripple network like to trade it against other assets.

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Be cautious however as on rare occasions the value has changed hundreds or thousands of percent a day.

Gateways Gateways are service providers that let Ripple users deposit, transfer, and withdraw money by means of their gateway accounts, including transfers between a consumer’s wallet and the consumer’s gateway account. To attract and retain users of their service, gateways will innovate and offer beneficial services to their customers.

As gateways compete for market share, I fully expect that more gateways will be launched that they will increasingly offer innovative rewards programs like airline miles, coupons, and premium service discounts. There are a number of services available to people who want to create and operate a gateway. If they have a strong technical background, they can usually set one up themselves. If they don’t have the technical skills, they can use a hosted wallet (more on that in a moment) or use consultants. If they are serious about getting into the

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gateway business. In the future, cloud­based options will be available such as OMG’s One Million Gateways hosted service. Because of Ripple’s design, anyone with a Ripple wallet can technically become a gateway.

However, that is neither likely or necessary in almost all consumer or investor cases. When people talk about “gateways” they are usually referring to a business setup to operate as such. A Ripple Wallet can become a gateway when people add “trust” to a wallet you control. “Trust” in the context of Ripple means “how much of my money do I trust this gateway to hold?” Gateways with an established history with a good reputation for customer service tend to be more trusted by users than new gateways that are less known and have a limited history of operation.

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This is an example of a gateway service login page using SnapSwap Inc. as an

example.

Here is what a basic gateway account experience looks like.

Gateways as a business have a few different business models available to guide them. One example is a gateway primarily used for money transmission, another example is remittance. As a gateway operator, you might be interested in enabling people to send payments to another country. A consumer opens an account on your Copyright 2014 ­ Andrew White

gateway and sends you money to go in that account. The gateway operator issues IOUs (more about those in the next section) to the account holder and those IOUs appear in the holder’s Ripple wallet. The account holder can than trade these IOUs for another currency. In the other country, a person can withdraw these IOUs from the gateway and receive the real currency. The gateway makes money by charging a transaction fee. If the original gateway’s website or service becomes unavailable, the IOUs do not disappear from Ripple wallets. In the event of bankruptcy or other serious disruption, the IOUs may lose some of their market value for the IOUs of currency they represent, but they could be redeemed when the gateway business returns. The unique circumstances of the gateways issue will decide what recourse is available to the IOU holders. The charts on RippleCharts.com contain the major currency markets on Ripple. These are typically written in the form of “Bitstamp USD/ XRP” to indicate that these IOU’s are issued by the Bitstamp gateway in the USD currency and is trading against XRP. Another example is the Chinese gateway RippleCN. Their IOUs for the Chinese Yuan look like this: RippleCN CNY/XRP. Back over at Bitstamp, you will see that Bitstamp USD is also able to be traded for Bitstamp BTC. Gateways can set rules on the fees of trades or policies as to what is allowed to be traded but in general all the IOU’s will be tradable for all the equivalent IOU’s on a given gateway. A quick word about adding trust to a gateway. Since anyone can create a gateway it is critical that you only trust a properly established gateway. This means it is at the very least incorporated and is run by publicly known corporate officers. If the gateway is operated in an anonymous manner, that means there is no accountability if the service disappears. This is important: in your Ripple Wallet, you should only give “trust” to gateway companies that you trust to be

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reliable and responsible with your tokens of value, e.g. money. Since a gateway is not usually a bank (at least at the time of this writing), note that there is no FDIC style insurance for deposits made to a gateway business. A gateway that makes an effort to be legitimate has publicly known staff, a business address, customer support details, and/or a phone number with people who answer the phone during established hours of business operation. If a Ripple gateway website disappears, your IOUs do not disappear from your Ripple Wallet. The problem is that redeeming those IOUs for their cash value is impossible unless a third­party gateway accepts them for their cash equivalents. I can sum this up simply. When it comes to anonymous gateways: don’t trust them. A standards group for gateways has been formed called the International Ripple Business Association (IRBA), which operates independently of Ripple Labs. I will discuss the IRBA more below but for now you should know the IRBA has a set of requirements to make sure that the gateways listed on IRBA’s website at http://xrpga.org are legitimate organizations, operate using best practices for businesses, etc. There are roughly 170 members of the IRBA at the present time, including people who have expressed their interest in forming a gateway for certain markets or areas in the world.

Consensus Consensus is where we start to get into the nitty­gritty technical details of how Ripple works. You don’t need to know all of this info if it is not right for you. I like to tell people understanding how everything works is not a requirement to invest in a Ripple based asset. There are a lot of complex things in life that do not required a full understanding of

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how it works. A couple of tech examples include are exactly how computers work or exactly how a web browser works. We assume that the professionals that make these tools know what they are doing and they can spare us the gory details and let us move on to do what we want to do with the tool. So with that said, I just want to make sure that you understand Ripple to the low level code and protocol is likewise not a requirement to understand the ideas of Ripple so if the technical details do not interest you feel free to skip over this section. If you are familiar with Bitcoin like currencies you may have heard that Bitcoin works through a scheme called “proof of work.” Proof of work is a process in which computers co­operate on solving a hard math problem that initially none of them know the answer to. When the answer is found, the computer that solves the problem is awarded a “block,” an award of Bitcoin (25 at the time of this writing) and the block is distributed along to all the other computers with a copy of all the transactions that took place in the prior block. This is what allows transactions to take place. In technical terms, this solves an important problem of how to solve the “double spending problem.” A double spend is someone spending the same units of currency twice. If everyone thought they could just use spreadsheets to create a cryptocurrency, they would soon find that someone would cheat by manually changing how many payments were sent. Another problem this solves is referred to in academic circles as the “Byzantine Generals problem” which is how to communicate along untrustworthy paths. This problem has existed for a long time and one way of solving it was released to the public in 2008 by Satoshi Nakomoto, the anonymous creator of Bitcoin. In 2011 Jed McCaleb was thinking of ways to solve some of the problems with the “proof of work” system. In particular, Jed wanted to solve the slow transaction time of Bitcoin. Waiting for computers to solve the proof of work problem on Bitcoin

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can take ten minutes or hours in time and that wait time is not good for merchants or consumers using the system. What he came up was a new approach called Consensus. If the majority of computers on a digital currency network could agree that a transaction happened there would be no reason to doubt that a transaction transpired. The proof of work system relies on several computers agreeing that a transaction occurred, which is called “confirmations.” After enough confirmations occur it can be reasonably be assumed that a transaction did in fact take place. With a consensus based approach, transactions could take place in seconds rather than minutes. There can also be a lot more transactions since the computational cost of this system is low. This brings us to another problem that has long been an academic puzzle, the Byzantine Generals' Problem. This problem asks, “how do two generals come to an unanimous agreement when they are separated by distances that create obstacles to communication?”

One answer to this problem is done with the Ripple software, the network is setup to validate a transaction if 80% of validator nodes agree a transaction took place.

Next I’m going to extensively quote Ripple Labs Chief Cryptographer David Schwartz who has a lot to say on this important topic: “The number was determined by simulation. If you set the threshold too low, the consensus process completes very quickly but more frequently doesn't actually reach consensus. If you set the threshold too high, the consensus process takes much longer, but only very rarely fails to actually reach consensus. (When you say, "I believe

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there's a consensus", you can't actually be 100% sure there is in fact a consensus or nobody can declare a consensus first.) The conclusion that no consensus has been reached is a valid conclusion and can result due to poor topology or Byzantine failure. Certainty is always with respect to something that has occurred in the past. It is not possible to know with certainty the present state without observing at more points than will normally be possible.

So each server runs out ahead of what it knows for certain, applying transactions and attempting to reach consensus on them. When and if a consensus is in fact produced, the server later determines this with certainty, and thus can advance what it knows for certain.

Essentially, the consensus process produces a stream of signed messages called "validations" from which it's possible to determine with certainty whether a consensus had actually been reached at some point in the past.

It is possible to create UNL topologies that frequently fail to reach consensus. The plan is to have Ripple servers build their UNLs using an algorithm that makes such topologies exceedingly unlikely.

Even with a perfect topology, two types of Byzantine failures are possible.

One, which is not that uncommon (one out of every 200 rounds or so), is a local failure. In order for a consensus to ever arise, someone has to declare a consensus. And for that to happen, someone must declare a consensus first. When that happens, whoever makes that

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declaration can't know for certain that others will declare that same consensus (or they would have already done so, and so he wouldn't be first). So it's always possible that he declares the wrong consensus.

In this case, the server that suffered the Byzantine failure quickly discovers that the other validators have built a different ledger than it did and it begins its resynchronization process. Other servers will still, from the validations, which ledger was the majority ledger.

A much less common type of failure is complete Byzantine failure. In this case, several servers declare different consensuses and there is no clear majority ledger. In this rare case, the network as a whole must reconverge before a true consensus will emerge. Ripple has an algorithm to do exactly this. Servers will see the conflicting validations and know with certainty that there was no actual consensus.”

On the Ripple forum recently, a mathematically minded member asked David the following question “How does Ripple solve Byzantine Generals' Problem such as no solution unless n ≥ 3t + 1, n = number of processes in the system and t = number of traitors?”

So how Ripple solves the Byzantine Generals problem is simple. The consensus process is permitted to fail because it does so harmlessly. If the consensus process forms a ledger on which there actually is no consensus, then there will be insufficient validations and the consensus process will repeat. To put it in Byzantine Generals terms if you get to the battle and the other armies aren't there, you just start over, nothing catastrophic happens.” In other words, keep trying until

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the vast majority of messages agree a transaction is accurate. Perhaps not surprisingly this simple but elegant solution has wide ranging ramifications.

And with that we can wrap our review of how Consensus works. For more information please check out the Ripple wiki pages at https://ripple.com/wiki or https://ripple.com/wiki/How_it_works

Validators

Since we are discussing the technical details of how Ripple works, for completeness I just to mention “Validator nodes” and what they do.

The Ripple wiki has this to say about validators “The Ripple protocol depends on a collection of validators who participate in the consensus process and produce signed ledgers which get broadcast into the peer to peer network. Clients and peers collect and depend on these signed ledgers to determine what is the consensus ledger, or the "true" state of the ledger. Crucial to the security of the network is that each Ripple server choose to pay attention to a sufficiently large diverse set of validators who are not colluding to defraud.” When 80% of validator nodes agree that a edger is valid it gets signed and confirmed across the entire Ripple network. This is an alternative solution to the “Byzantine Generals problem” first solved by Bitcoin with mining.

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Currency IOUs

IOU’s (“I owe you’s” pronounced how it is spelled, “eye oh u”) are credits and are what most people will use on Ripple. IOUs stand for “I owe you (something).” We are most familiar with IOUs from our banking or investor statement that is mailed monthly by financial service providers. An IOU is a promise that a certain amount of funds that the IOU issuer controls are funds in your account. The reality is that the IOU holder has a total amount of funds that it controls and, from this total, they use a database to organize what they owe their customers and the number displayed to you is the IOU. IOUs on Ripple network operate on the same principle, but instead of a banking or investment entity creating and displaying the IOU to you, an IOU on the Ripple network is an asset created by a Ripple gateway indicating “I promise to redeem you a specific amount of this currency asset.” If you received a payment for US dollars, you would see the deposit of the USD IOU’s in your Ripple Wallet.

IOUs are what make Ripple “the email of currencies.” The email protocol does not care who you are sending a message to, or the content of your email and Ripple works the same way. The sender and recipient of an email is like the sender and receiver of Ripple wallets, the message in an email is similar to “what currency” and “how much” is sent in the transaction (the message, in our email analogy). The final lesson you should take away from this is that an IOU has no value when it is not backed by an asset that can be redeemed.

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Pathfinding “Pathfinding” is another one of the technical details that I include for completeness and is fairly self­explanatory. This is how Ripple finds ways to make the best available payment. The price on a transaction fee can vary in Ripple based on the best possible exchange rate on the order books of Ripple currencies. As this diagram from Ripple Labs illustrates:

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Pathfinding is of most interest to market makers and technical types to be able to serve market activity. It is important to note that although Ripple is fast it is slow enough as to make high frequency trading impossible and a part of the reason why that is is because of the time it takes Pathfinding to work, a few seconds is too slow for HFT to be effective.

Traders

Anyone with a Ripple wallet can trade the digital currency assets on Ripple. Sending a payment of any sort using the Ripple network is equivalent to making a trade on the foreign exchange (also known as forex and FX) currency markets.

Each currency has a three letter abbreviation, and each currency trade is expressed as a pair that includes the base currency and a counter currency. Each currency pair (USD/XRP or EUR/JPY or Copyright 2014 ­ Andrew White

CNY/BTC, etc.) is supported by a gateway that has an order book of buyers and sellers of a particular currency pair. The daily trading volume on the Ripple market is growing rapidly. At the time of this writing (March 2014), the most popular currencies traded are Chinese Yuan (CNY), USD, and BTC. Automated trading is a popular choice for investors with the technical know how to work with programming scripts to make a “trading bot.” These bots connect to the Ripple network and look at the bids and asks in certain currencies and trade according to user defined parameters. Most of these bots require a fair amount of technical knowledge and skill to setup and use. Although there are no algorithmic trading services available to investors at the moment, these are known to be in development. “Trade and forget” bots can be extremely valuable as they work for you around the clock without tiring or miscalculating.

Off market trading can also be very lucrative. Finding a market that wants XRP but does not have the know­how how to get it is an excellent way to build a business and increase Ripple adoption. If you want to engage in off market trading, please get informed of local laws before beginning. In the United States, to cite one example, transactions greater than $10,000 need to be reported to the Federal Financial Crimes Network (FinCen).

Market Makers

Market makers are people who provide liquidity (i.e., money) between gateways to allow payments through a “pathway” of currencies to be

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made. Much like how a road provides a path for a car to reach its destination, a pathway is the route a transaction takes to complete a payment. Although there are a few ways to become a market maker, the easiest is with a simple order in the Ripple wallet for the same currency between the two or more gateways you want to market make for. It should be noted that anyone can be a market maker but it helps to have a lot of capital to make it more worthwhile for the markets you are trying to support.

Enterprises The Ripple ecosystem is likely to see powerful waves (ha!) of new services developed to take advantage of the new found possibilities that Ripple provides. The most obvious area at the time of writing is gateway services. Merchant services, remittance options, charities, experimental hobbies, and commodities also are all promising areas for innovators to place their stake.

A number of interesting companies have formed based entirely on the Ripple protocol. Companies such as Fortune Harbor, Coinst, RippleWise, SnapSwap, and others are leading the way in terms of innovation and proving that the Ripple system is a viable business model. Companies older than Ripple have also signed on to use the service, most notable to date is Bitcoin exchange Bitstamp.

Creating or investing in a new company in the Ripple ecosystem is an attractive option to the investor familiar with managing equity assets. Ripple is so new and the opportunities it offers so largely untapped,

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that the door is wide open for enterprising individuals and startups to make a substantial impact with little startup costs. If this is something that interests you in pursuing a business I strongly encourage you to do so. Complementary services that add value to the Ripple network is something Ripple Labs is very interested in supporting and you should let them know about it once you are ready to launch.

Due Diligence Questions

Investors should be asking themselves some hard questions and have honest answers before beginning to invest in Ripple. Here are some basics for you to consider:

How well do I understand Ripple? What do I not understand about Ripple? What are the risks involved? What are the legal and regulatory issues impacting Ripple in my country of residence? What do I know about the principals in the enterprise in which I might invest? Do I understand all the counterparty risks? What happens if the Ripple software becomes fundamentally broken and can’t be fixed? Who are the major customers and the applications related to investment opportunities? What are historical and projected growth rates?

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What is the expected market timing of new products, services, or enhancements?

Along with these specific investor questions, I wanted to share this list of best practices from the Ripple wiki:

You must protect yourself:

Ripple Labs Inc. does not endorse, qualify, or guarantee the performance of any merchant or gateway. Do not trust services operated anonymously, you have no recourse if they fail to deliver on their promises. Do not enter your Ripple username and password on any site you do not trust with your funds. Do not enter your Ripple username and password on any site that does not use https. You can usually tell when a site uses https when your web browser has a green lock next to the website address in the address bar. Do not use a client provided by an entity you do not fully trust. You must trust your client provider to be honest, secure, competent, up to date, and perhaps more. For long term storage of XRP or IOU’s in a “cold wallet” consider using the Desktop Client. You should use a password so long and random you cannot remember it (only store and copy it securely).

In the Future

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The future will certainly bring many exciting and interesting areas for Ripple investors to consider. In particular, I’m excited for the time when options trading becomes more widely available (which will likely be easier with the advent of “smart contracts” later in 2015). Smart Contracts could become the killer app for math­based currencies. For example, by using some particular math functions it is possible to issue shares for a company or raise funds. In July 2014 Ripple Labs announced Codius, a new project to enable smart contracts. Codius will allow people to create offers or contracts across for any digital ledger system so that they can all benefit. They do this through some innovative design choices that allow people to make useful applications with any pre­existing programming language. I spoke with Stefan Thomas the CTO of Ripple Labs who explained to me that the design was informed from the example that business logic and data storage (databases or decentralized ledger’s like Bitcoin) are two separate topics. Every web service in existence uses a database to store information and business logic on top of the database to decide what goes into it. I should probably mention a computer science term that will be helpful to understand why this design decision was taken. Computers run software in one of two ways. One is deterministic, code executes in the same way every time. The other is non­deterministic which means it can execute differently every time. What is good about this approach is that it makes Codius completely platform neutral. Any programming language can use it and any digital asset system can use it’s approach. Codius uses another concept called “Smart Oracles.” A smart oracle is anything that can be “asked a question” and a non­biased answer is returning. One example could be asking the stock market what the price of a given stock is. Another example is asking the Bitcoin network if a certain transaction happened. The important thing to understand is that Codius is neutral

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as to whom you ask your verified questions and how you do it. You might want to make a contract on stock futures and hedge on the price of Bitcoin and or the temperature of Daly City, if all the answers “add up” to the threshold of “truth” as written in your contract the terms will be met and the code executes. This is very different from every other system out there and something that creative people will make amazing applications with. The Codius approach to smart contracts frees developers from being locked into any one system which is the Holy Grail for next generation financial and business applications. To learn more on the subject of smart contracts, I highly suggest a thorough reading of “Great Chains of Numbers” by Tim Swanson. New services for Ripple wallets are coming out all the time including Shift Payments who are releasing a credit card that ties into a Ripple wallet in late 2014. Like any active protocol, Ripple faces intense scrutiny to identify and correct any inefficiencies as well as for ways the protocol can be improved. Ripple (and Codius) is such a disruptive new technology that its full impact on business and society will not be known for many years. The day will come when people will be so accustomed to a multi­currency wallet that they will ask “why didn’t I think of that?” In my opinion we are witnessing the dawn of a disruptive technology as big as an advancement as digital stock markets or paper currencies. Important Ripple Infrastructure

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Beyond Ripple Labs there are a number of important resources and services that is available to the Ripple community. Foremost about those are community forum’s where issues related to Ripple are discussed. The most active of these are XRP Talk ran by a community member in France and the Ripple Labs Forum. A couple of new services have come into being recently that are useful as well, LibreTax for taxes in the U.S. and Coinist for public reviews of gateway services. The most well known Ripple gateway right now is Bitstamp, the world’s largest Bitcoin exchange. There are a variety of other projects under development right now. There are at least four venture capital backed companies created specifically for the Ripple ecosystem that I know of. There is also a lot of discussion about ways to improve the Ripple world with new features and more services. It is going to be an exciting few years for important innovations to be brought to market. For technical infrastructure, I expect to see more services to enter the market to serve as engines to drive the growth of digital assets and useful things that can be done with them. My own company One Million Gateways Inc. was established to help these companies reach their full potential.

FAQs

How is Ripple different from Bitcoin?

The two are completely different. The most basic answer is that Ripple is not designed to be used as just a currency. Instead it is a payments protocol. The difference is between Bitcoin being a p2p virtual currency and Ripple as a p2p exchange. Bitcoin uses the “proof of work” mechanism commonly known as “mining” to generate Bitcoin Copyright 2014 ­ Andrew White

and or verify the validity of transactions. Instead, Ripple uses a system called “consensus.” This fundamental difference with Bitcoin means that they work differently and that they are designed for different purposes. Bitcoin or other currencies are not competition for Ripple. My understanding is that Ripple Labs wants to see other payment systems settled or traded on Ripple and not compete with them.

I heard that mining digital currencies requires an incredible amount of electricity, is Ripple similar?

Thankfully no. Ripple requires no more electricity to run securely than a normal high­end computer server. The megatons of CO2 and megawatts of electricity and power bills used by other alternatives is not an issue with Ripple.

I heard that Ripple is a pre­mined currency, is that true?

The answer is both “yes” and “no.” Ripple was not created or released as a currency platform that used mining to generate the currency and verify transactions. People that mine or believe in the idea that mining is fair due to the equal probability of being rewarded for doing the proof of work. There is nothing wrong with that opinion. However Ripple successfully solved some of the inherent and fundamental problems that mining brings to a digital currency: the slowness of transactions, the 51% attack problem, block chain splits, etc. In defining the utility of cross currency payments, a fundamental design principle is that long delays for payments is not acceptable. Let’s face it, nobody wants the uncertainty of waiting for a payment to confirm

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and Ripple can make trading those kinds of assets faster and more secure. Do any banks use Ripple?

At the time of this writing there are a few banks who have claimed they will be using the Ripple protocol.

What are validators? The Ripple network relies on dedicated computers called validators to confirm that transactions are valid, why is this?

Validators are the “lightweight” way to verify that transactions are valid compared to the “heavyweight” use of crypto­currency mining algorithms. They are lightweight because you only need a few computers doing this (instead of thousands in traditional digital currencies). By design, Ripple Labs created the Ripple network to rely on validators that they run and they know can be trusted to make sure that transactions are valid. The majority of the validators that a gateway trusts must be trustworthy. If the majority of them become malicious or conspire against the gateway, they can make fraudulent payments against the gateway. The way to mitigate this threat is by using community accepted trusted nodes such as those run by Ripple Labs.

I heard someone forgot their password or had their Ripple coins stolen, are those coins or wallets inaccessible forever?

Copyright 2014 ­ Andrew White

Yes, unfortunately they are inaccessible forever. Neither Ripple Labs nor anyone else can restore your password or recover stolen coins. Payments in Ripple are irreversible due to how some of the low level math functions work (for more information on the underlying technologies, you can research “public key cryptography” and “message signing”).

I want to know more about how to setup a gateway, where do I start?

https://ripple.com/wiki/index.php?title=Ripple+for+Gateways is a good resource. I would also love to talk to you about your idea and help you become successful.

What is a Secret Key?

Your wallet’s Secret Key is your “secret entrance” into your wallet if you ever forget your password. On a technical level, your Secret Key can also be used as part of a program to do things for you such as running a trading bot. Secret Keys are named “secret” because they must be absolutely unavailable to anyone but those trusted to access the account. If someone gets your Secret Key, they can do whatever they want with your assets. If you are have reason to believe someone has gained unauthorized knowledge of your Secret Key, you should create a new wallet and send your assets over to the new wallet as soon as possible.

What kind of venture capital or incubators are available to Ripple developers?

Copyright 2014 ­ Andrew White

The recently launched Crosscoin Ventures is a good starting point for Ripple developers seeking funding. Headed by entrepreneurial startup and VC veterans, Crosscoin has the enviable position of being located in the same office building in San Francisco as Ripple Labs. Look for a number of high quality and innovative services to emerge from the Crosscoin accelerator.

What is the best technical resource for Ripple?

The best Ripple documentation resource is located at https://ripple.com/wiki/ Developers can also check out http://dev.ripple.com/ For further information, I suggest connecting with the developers on the IRC channel on the Freenode network #ripple. I want to learn more about Consensus, where do I find more info? The Consensus Whitepaper released in August 2014: http://dev.ripple.com/consensus­whitepaper.html

I don’t like how Ripple Labs does X Y or Z, what do you have to say about that?

Ripple Labs is a very young startup. Expectations for this service are high, perhaps too high. It takes time to build world class teams, and staffing resources are always limited. Give your issue some time and I

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am certain that you will eventually see improvements to the issue you are concerned with. What are software “forks”?

Software forks happen when one group of software developers decides to take the source code from a project and make their own possibly incompatible changes from the prior version of the software. This can happen for various reasons but the most likely reason is that one group of developers disagreed with the direction a project was going. This can be either a good or a bad thing. It is bad when it divides the number of people working on a project. It can be good when the forked software makes improvements the other developers were not willing to make. Alternative versions of Ripple are expected to be released in the future and this is good for the Ripple protocol since new ideas can be tested in different networks.

What are good community resources for getting answers to my additional questions?

My favorite resource is the forum at https://ripple.com/forum/ but the most popular community forum is https://xrptalk.org/ How does Ripple Labs sell Ripples? Do they sell on the open market?

According to Director of Communications Monica Long they do not:

“Ripple Labs isn't and has never sold XRP in the open market. We sell

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the portion of XRP reserved for business operations through direct

wholesale purchases on a measured basis. What we've seen recently

is a wholesale buyer selling a significant volume in market. We've

changed the terms of wholesale purchasing to limit market impact in

the future.”

I have something I want to discuss with Ripple Labs, what is the best way for me to do so?

Talk to the business development team at partners@ripple.com or the developer relations team at developers@ripple.com. I want to start a currency issuing gateway, but I have no experience and no capital, how do I get started?

First of all I applaud your enthusiasm for Ripple and adding value to the network. However I would advise against starting a gateway on your own. Gateways are powerful tools and with no background in compliance, regulations, or the technical risks with using Ripple you would be doing your customers a disservice starting out with no experience. I would suggest you find some equally excited partners with experience in the payments industry or digital currencies before moving forward.

Glossary Copyright 2014 ­ Andrew White

Bitcoin ­ A “proof of work” digital currency created in 2009. The benefits of Bitcoin is that it is nearly impossible to counterfeit (i.e., make fake Bitcoin) which makes it useful for online payments. Bitcoin solved two longstanding academic problems, the “double spend” problem and the “Byzantine General’s” problem that allows it to work in a secure, decentralized manner.

Codius ­ This is a technology­neutral framework for creating smart contracts. More info can be found at http://codius.org/ Due Diligence ­ is the process of thorough research before making investments. Enterprises ­ include business startups in the Ripple ecosystem, such as new gateway services, merchant services, remittance options, charities, experimental hobbies, and commodities – all are promising areas for business innovators and early stage investors. Gateway ­ a service provider that enable users to deposit money into and withdraw money out of their gateway accounts on the Ripple network. In technical terms a gateway is an asset issuer. Gatewayd­ Gatewayd is an open source server that makes building applications on top of ripple easier. For more information please see https://gatewayd.org/

Copyright 2014 ­ Andrew White

Ripples ­ the Ripple network’s native currency, represented by the letters XRP. In order to use the Ripple network XRP must be used. Each transaction deletes a tiny amount on the Ripple ledger forever. Ripple Client ­ This is the software that is useful for user experiences on web services such as a wallet.

Ripple Labs, Inc. ­ owns the intellectual property of the Ripple protocol, and promotes Ripple’s wider use and greater usefulness. Ripple server ­ Also knows as rippled, this is the software that connects all ripple servers together into a decentralized network around the world. Gateway operators need to use one in order to have their service use the Ripple protocol.

IOU ­ is a promise that a certain amount of funds that the IOU issuer controls are funds in your account. An IOU on the Ripple network is an asset created by a Ripple gateway indicating “I promise to redeem you a specific amount of this currency asset.”

Trader ­ people who use their Ripple Wallets to exchange currencies (govt.issued currencies like USD, CNY, etc. and digital currencies like XRP, BTC, etc.), functionally similar to trades made on the Foreign Exchange (FX) currency markets.

Market Makers ­ provide liquidity (i.e., money) that allows payments to follow a “pathway” between gateways.

Copyright 2014 ­ Andrew White

Stellar ­ A Ripple clone funded by Stripe.com. The main difference with Ripple is that Stellar tokens are an inflationary asset instead of a deflationary one. Validators ­ dedicated computer nodes that confirm a transaction is valid through the Consensus process. Validators are the key to transaction verification threshold being reached and only need to be used by experts or people running professional gateways. Wallet ­ the digital account where individuals hold, access, and use their digital currencies in Ripple. Wallet Vault ­ A wallet vault, also called a “wallet blob” is the encrypted storage of Ripple wallet secrets. The wallet vault is created in such a way that the service hosting the wallet blob cannot read the contents of the data or compromise integrity.

About the Author

Andrew White serves as the founder of One Million Gateways Inc. a digital currency consulting company. He also serves as Secretary at the International Ripple Business Association, which is the premier organization of merchants and businesses that use the Ripple protocol. Andrew has been active for years in the Bitcoin communities

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in San Francisco and the Bay Area, and began using XRP soon after its introduction.

Copyright 2014 ­ Andrew White